Under the Patient Protection and Affordable Care Act (PPACA), state governments are expected to set up health insurance exchanges through which individuals will buy their own health insurance, in many cases with substantial subsidies.Should the states comply? In the following point-counterpoint discussion, Linda Gorman and I give opposing answers to this important question. Leave your thoughts in the comments.

John Goodman: Yes

If the states abdicate their responsibilities under PPACA, the federal government will step in and act in lieu of the state. Under this scenario, states will relinquish all power to make a bad law better. Letting the federal government implement reform almost guarantees bad outcomes.

Linda Gorman: No

Exchanges are required to perform a variety of duties beyond distributing ObamaCare subsidies, and these duties are likely to add significantly to estimated costs. Some of them will damage a state’s business climate by creating new opportunities for crony capitalism. Some require that currently fashionable, but poorly tested, models be forced on health care providers. Some require that state exchanges have expertise equal to private insurers. Others force states to increase the cost of health insurance for people who currently have coverage.

“I’ve got better things to do.”

John Goodman continued:

The states should engage in preemptive reform over the next two years. This means enacting responsible, rational reforms — the kind of reforms that they should have enacted all along, in the absence of federal legislation. Where possible, states should try to make their reforms compatible with the new federal law — but only if compatibility does not sacrifice the major goals of the state’s reform.

There are four arguments in favor of preemptive action at the state level:

If states enact their own reform and if it is achieving most of the goals of the federal law in a reasonable way, they may be able to secure a federal waiver to continue with whatever they are doing.

There is some possibility that the federal law may be found unconstitutional or it may be repealed altogether. In either case, the states will be able to continue with their good reforms without federal interference.

There is a high probability that PPACA will be subjected to major modification within the next three years—barring an outright repeal or a finding of unconstitutionality. An amended PPACA will likely grandfather any state reform that appears to be working reasonably well.

Even if the states are forced to modify their reforms in major ways three years from now, the end result is likely to be much better if the system being modified is a good system to begin with than if a set of perverse federal rules are super-imposed on a pre-existing dysfunction of system.

State Responsibilities under the New Law. States are required to do a number of things under the PPACA. These include:

Setting up and administering a new risk pool for people who have been denied coverage because of a pre-existing condition.

Enforcing new health insurance regulations, including no ceiling on annual and lifetime spending, limits on the amount insurers can spend on overhead, enforcing a prohibition on pre-existing condition provisions in child-only policies, etc.

Beginning in 2013, enforcing a prohibition on adjusting premiums to reflect an individual’s expected health care costs, enforcing guaranteed issue in the individual market—both inside and outside the health insurance exchanges—and limiting the spread of premiums charged to different individuals at different ages and in different occupations.

Regulating health insurance premiums in the individual market.

Setting up health insurance exchanges and administering federal subsidies for individuals who purchase their own health insurance, beginning in 2013.

Managing a major expansion of Medicaid, including families with incomes up to 133 percent of the federal poverty level, beginning in 2013.

Managing the flow of people who move back and forth between the federal/state-funded Medicaid program and the tax-subsidized health insurance exchanges.

All of these responsibilities are challenging. They are costly and administratively difficult. Hence, it is tempting for the states to dump the problems back in the lap of the federal government.

What if States Do Nothing? More than half the states have already decided not to operate the new federally funded risk pools—which make health insurance available to people who have been denied coverage for a pre-existing condition—for the same premium healthy people would pay. In these states, the risk pool is being operated by federal authorities.

It is understandable that states would have little interest in operating a fund with downside risks and no obvious upside benefits. But for states that take my advice and implement preemptive reform, this decision may have been unwise.

The biggest problem in health reform is the problem posed by people known to have high health care costs. As a result, the greatest help a state can get in transitioning to a new health care system is a pool of money to pay for those costs—even if only for three years. A well-funded risk pool should be an element of rational state-level reform.

Here is a principle to keep in mind on this and on many other issues: It is in the states’ interest to shift costs to the federal government wherever possible; it is in the federal government’s interest to shift costs to the states. With respect to a risk pool or a health insurance exchange there will be hundreds—even thousands—of decisions made on a day-to-day basis, that are hard to review and even harder to undo. From the state’s perspective, who do you want to make these decisions?

Let’s consider three areas where decision-making authority could be worth millions of dollars to state governments.

First, if state governments abdicate their right to set up health insurance exchanges, the federal government will step in and set up federally regulated exchanges in those states. But the official who stands at the entrance door of the exchange will be the person who will decide whether an applicant is entitled to federally subsidized insurance or whether that person should be getting insurance from an employer or from Medicaid. Consider also that whatever decision is made, no one will know if it was the right decision until an audit is done five years after the fact; and at that point there will not be much that can be done about it anyway.

In principle, there is nothing wrong with a health insurance exchange. What is wrong with existing exchanges is that they give health plans perverse incentives to underprovide to sick people. But an exchange that did not have such perversions built into it could be a valuable institution.

Second, consider the regulation of premiums for plans sold in the exchanges. The Obama administration’s goal for controlling costs in Medicare is immensely transparent. The administration wants to force seniors into super HMOs called Accountable Care Organizations (ACOs). It will then limit the income of the ACO—forcing it to ration care. In doing this, the administration will be following a precedent that is already underway in Massachusetts.

With that in mind, who do you want to regulate private insurance premiums in your state? If the federal government does it, the tendency will be to replicate what is happening in Medicare. The regulators will try to keep the growth of premiums below the rate of growth of health care costs. This will not really control costs but it will limit the size of the subsidies the federal government has to pay. In the process it will force health plans to ration care.

A third area where decision-making authority will be worth millions of dollars is the ability to determine whether an individual or family qualifies for Medicaid or qualifies for insurance in the exchange. Under Medicaid, the federal subsidy is much lower and the state has to pay a good portion of the cost. In principle, eligibility for Medicaid follows in a straightforward way from objective criteria—mainly family income and assets. In practice, however, people’s income and assets are changing all of the time. It’s not unusual for a family to be eligible and then ineligible for Medicaid several times in one year. According to one study of the problem, within six months, more than 35 percent of all adults with family incomes below 200 percent of the federal poverty level will experience a shift in eligibility from Medicaid to an insurance exchange, or the reverse. Within a year, 50 percent, or 28 million, will.

In the light of all this movement and flux, the ability to make decisions about who should be in the exchange and for how long could be worth an enormous amount of money to the state. Keep in mind that a family at 133 percent of the poverty level will get a benefit in the health insurance exchange in excess of $20,000,according to estimates of the Congressional Budget Office. Medicaid spending will probably be less than half that amount and the federal government doesn’t even pay all of that.

Bottom line: states should at least consider retaining as much decision-making power as they can get.

In a future Health Alert, I will discuss the elements of pre-emptive reform.

Linda Gorman continued:

Once an exchange is established, a state must:

Reimburse the exchange, but not private insurers, for the cost of any new health insurance mandates.

Establish a reinsurance program for the first three years of operation. Fees will be collected from health insurers and used to “stabilize premiums” in the individual market. This increases health coverage costs for people who have existing coverage.

Operate a risk adjustment program that collects risk-related data to determine individual risk scores. Private insurers have historically used experience based rating, not risk scores. Risk adjustment has not worked for Medicare Advantage.

Coverage offered through an exchange must:

Meet a variety of reporting and document standardization requirements.

Distribute grants to selected community groups “hired” to replace the services of traditional insurance brokers under PPACA’s “Navigator programs.”

Establish network adequacy standards that have no minimum requirement except that they cover a “sufficient number” of “essential community providers.”

Meet a variety of quality improvement requirements that, in pilots, have been shown to increase costs with little improvement in care:

John C. Goodman is president and founder of the National Center for Policy Analysis, a free-market think tank located in Dallas, Texas. The Wall Street Journaland the National Journal, among other media, have called him the “Father of Health Savings Accounts.” Dr. Goodman’s health policy blog is the premier right-of-center health care blog on the Internet. It is the only place where pro-free enterprise, private sector solutions tohealth care problems are routinely examined and debated by top health policy experts across the ideological spectrum.